Thursday, August 9, 2012

Some economists continue to argue that the sharp declines in money supply measures in some Eurozone periphery countries (see posts here and here) is meaningless because the measures need to be made vis-à-vis the remaining Eurozone private sector. The argument goes that it's the equivalent of measuring money supply for one of the states in the US. But evidence is accumulating that this way of thinking about the Eurozone periphery is utter nonsense. Periphery nations are becoming increasingly financially isolated, not just from the Eurozone core but from each other. In particular cross-border financial transactions among banks are dwindling.

The latest ECB data is showing for example that cross-border overnight money market transactions are rapidly declining (both secured and unsecured). That is Spanish banks transact with each other but not with Italian or German banks. Fragmentation is on the rise.

The fragmentation is showing up in banks' mistrust of other Eurozone nations, severely limiting credit to non-domestic institutions.

ECB: - The growing significance of perceived
country risk in the money market is also
illustrated by the findings of an informal
survey conducted among the major euro area
banks represented in the ECB Money Market
Contact Group in March 2012. It showed
that country risk is the most significant
consideration when assigning counterparty
credit lines. 75% of the respondents said
that they apply different haircuts to the
assets in repo operations depending on the
geographic origin of the counterparty. In
addition, more than 60% of the respondents
have operational restrictions on the euro
area countries that are most affected by the
sovereign debt crisis.

Even the collateral posted at the ECB is increasingly domestic. Banks use primarily bonds from the country of domicile as collateral to borrow from the ECB.

Of course cuts in exposure to the periphery banks are particularly extreme.

ECB: - As a further indicator of market
segmentation, the Bank for International
Settlements (BIS) first quarter data showed
that cross-border claims of European banks
on EU/IMF programme countries and on
Spain and Italy have decreased significantly
since 2008. Meanwhile, cross-border claims
on Germany rose sharply, reflecting safe haven
flows.

The goal of stronger Eurozone integration is becoming ever more elusive as trust among institutions of the various nations evaporates. And it's is not at all clear that a centralized banking regulatory system will help improve the situation.